How Rising Interest Rates will affect Your Pocketbook

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By summer of last year interest rates had fallen to 45-year lows, sparking one of the greatest booms in real estate in recent history.  In June of 2004, the Federal Reserve, led by Chairman Alan Greenspan, reversed this trend by raising interest rates for the first time in several years.  Since then, the Federal Reserve has raised interest rates five times and it is expected to raise rates again when the Board meets next month.  In fact, the consensus of Wall Street analysts is that the Federal Reserve will continue to raise rates throughout this year and next.  If this trend proves correct, how will your pocketbook be affected and what are the smart moves you should make now?


This raising of interest rates by the Federal Reserve should have the desired effect of slowing down our economy.  In fact, there are already signs this slowdown is happening. This in turn reduces expectations for stock market returns, as corporations must pay more to finance operations and growth.  If stocks are likely to underperform their historical expectations, this might be a good time to turn your attention to your current debt load.  What you should do now:

·        Mortgage rates.  As I write this, you can get a 30-year mortgage for about 5.5%.  If you own a home with a mortgage, review your rate and if it exceeds 6.5%, consider refinancing.  If you have an Adjustable Rate Mortgage (ARM), you need to do some homework to figure out if this is a good time to switch to a fixed rate loan.  If you are renting, this may be your last opportunity to buy a home with low interest rate financing.

·        Equity Line of Credit.  Many people have borrowed money on their home using an equity line of credit to finance everything from home improvements, auto purchases, to consumer loan consolidation.  As interest rates continue to rise this year and next, the interest rates on these loans will rise also.  Consider using extra cash to reduce your equity credit line.

·        Credit cards.  The average interest rate on credit card debt is 13.5%.  In addition, most credit card issuers retain the right to raise rates simply by giving you notice.  As rates rise, so too will interest rates of your credit cards.  One of your first priorities should be to reduce your credit card debt.

·        Consumer loans.  Review your consumer loans (auto, retail stores, etc.) to determine how much interest you are paying and whether the company has the right to raise the interest rates.  Some will be fixed, others will not.  Focus your attention of paying off the ones with the highest rates and the ones that allow the company to raise interest rates.


In a year when we expect the stock market to deliver, at best, mid-to-high single digit returns, paying off debt may be your best investment for 2005.  Be sure to prioritize your debts so that you first pay on debts with the highest, non-deductible interest rate.